Misallocation and Financial Frictions: Some Direct Evidence from the Dispersion in Borrowing Costs

30 Pages Posted: 20 Nov 2012 Last revised: 10 Mar 2022

See all articles by Simon Gilchrist

Simon Gilchrist

National Bureau of Economic Research (NBER)

Jae Sim

Board of Governors of the Federal Reserve System

Egon Zakrajsek

Bank for International Settlements (BIS)

Date Written: November 2012

Abstract

Financial frictions distort the allocation of resources among productive units--all else equal, firms whose financing choices are affected by such frictions face higher borrowing costs than firms with ready access to capital markets. As a result, input choices may differ systematically across firms in ways that are unrelated to their productive efficiency. We propose an accounting framework that allows us to assess empirically the magnitude of the loss in aggregate resources due to such misallocation. To a second-order approximation, the framework requires only information on the dispersion in borrowing costs across firms, which we measure--for a subset of U.S. manufacturing firms--directly from the interest rate spreads on their outstanding publicly-traded debt. Given the observed dispersion in borrowing costs, our approximation method implies a relatively modest loss in efficiency due to resource misallocation--on the order of 1 to 2 percent of measured total factor productivity (TFP). In our framework, the correlation between firm size and borrowing costs has no bearing on TFP losses under the assumption that financial distortions and firm-level efficiency are jointly log-normally distributed. To take into account the effect of covariation between firm size and borrowing costs, we consider a more general framework, which dispenses with the assumption of log-normality and which implies somewhat higher estimates of the resource losses--about 3.5 percent of measured TFP. Counterfactual experiments indicate that dispersion in borrowing costs must be an order of magnitude higher than that observed in the U.S. financial data, in order for misallocation--arising from financial distortions--to account for a significant fraction of measured TFP differentials across countries.

Suggested Citation

Gilchrist, Simon and Sim, Jae W. and Zakrajsek, Egon, Misallocation and Financial Frictions: Some Direct Evidence from the Dispersion in Borrowing Costs (November 2012). NBER Working Paper No. w18550, Available at SSRN: https://ssrn.com/abstract=2178329

Simon Gilchrist (Contact Author)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
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Jae W. Sim

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Egon Zakrajsek

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

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